Ethical investment is an approach that’s not only about increasing your bottom line but also about supporting companies aligned with your personal values.
One of the reasons for its immense popularity is the environmental, economic, and sociological devastation unscrupulous companies have caused.
These days, many investors insist that companies they invest in treat their employees with respect, create products that don't harm the planet and steer clear of other unethical practices. With that, there are various types of investments that are considered ethical investments, including:
Ethical investing using negative screening
Environmental, Social, and Governance (ESG)
Socially responsible investing
Impact investing
Sustainable investing
Below, we’ll dive deeper into each of these and ethical investing as a whole.
A short history of socially responsible investment
Socially responsible investing began with the Religious Society of Friends (more popularly known as the Quakers), who adamantly refused to profit from the slave trade.
John Wesley was an eighteenth-century English cleric, theologian, and evangelist. He fervently believed that taking financial advantage of others was a grievous sin, unlike many of his contemporaries. He told his flock to avoid supporting industries that used materials toxic to human health.
He's famous for delivering a rousing sermon on "The Use of Money," outlining the basic tenets of socially responsible investing, including the following stirring line: "We ought not to gain money at the expense of life or by losing our souls."
Former World War I aviator Philip Carret launched the Fidelity Mutual Trust, the first publicly offered socially ethical investment fund, in 1928. It's enjoyed average annual returns of 12% since its beginning, regularly beating the S&P 500.
For decades, most socially conscious investors focused on steering clear of the so-called "sin industries," which were companies making liquor and tobacco products or promoting gambling.
This practice evolved in the 60s when socially aware individuals began investing in companies supporting the civil rights movement. The practice continued to grow in the 80s when people stopped investing in South African businesses because of the country's toxic apartheid policies.
The 5 main types of ethical investment
1. Ethical investing using negative screening
Some ethical investors use negative screening to make their investment decisions. This means excluding companies from their portfolio based on unscrupulous corporate practices.
Sometimes it involves screening out the so-called "sin stocks," which are companies profiting from sales of products that are perceived to be harmful. These are things like weapons, tobacco, gambling, and adult entertainment.
Other individual investors and fund managers are more interested in excluding companies that engage in such environmentally unfriendly practices as deforestation, fracking, or palm oil production. Others eliminate enterprises operating under repressive regimes or doing business in nations with poor human rights records.
Which companies get excluded depends on the criteria of the individual investor or fund manager. Some people eliminate a company based on a single corporate practice. In contrast, others are assessed on a case-by-case basis. Socially responsible fund managers consider many factors when making their decisions, including what percentage of the company's profits come from potentially harmful activities. Another factor is how committed the enterprise is to doing business more ethically.
2. Environmental, Social, and Governance (ESG)
Fund managers using this approach will look for enterprises that demonstrate exceptional behavior regarding environmental impact, social responsibility, or the quality of internal governance practices. This means that an ethical company scores high marks on each of these factors.
It's a positive impact rather than a negative one. According to the Forum for Sustainable and Responsible Investment, the amount of money in funds based on the ESG investment method rose from $569 billion in 2010 to $16.5 trillion in 2020.
ESG factors
With the ESG investment strategy, companies are shortlisted based on traditional financial metrics and future growth expectations. However, they’re also filtered based on these three predetermined characteristics:
Environment: Unsustainable corporate practices destroy countless ecosystems and reduce the availability of water and clean air. Environmentally conscious investors seek to minimize this kind of ecological devastation by investing in companies that help the planet rather than harm it.
Social: This ESG attribute is about social responsibility. This is critical to investors who want to make investments that are not only profitable but also contribute to the betterment of society.
Corporate governance: Good corporate governance is all about effective, ethical leadership. This means a company acts with a high degree of transparency and adheres to impeccable standards of conduct when running its business operations.
The limitations of the ESG approach
One problem with the ESG approach is that most enterprises don't fit neatly into “good” or “bad” categories but are composed of varying shades of gray. For example, a supermarket chain that stocks Fairtrade products but has a history of putting mom-and-pop shops out of business.
Using this method doesn't necessarily mean enterprises are excluded from investment consideration even if they're engaged in environmentally destructive practices. That's why a company like ExxonMobil, which emits lots of carbon emissions but is actively working to lessen its environmental impact, can be found in some ethical funds.
It's up to individual asset managers to determine if fossil fuel, tobacco, and similar companies have enough redeeming qualities to rank high on their ESG scorecards.
Kellogg’s and Google
Keep in mind that no company will have a perfect environmental scorecard. Ecologically minded investors will find good choices in companies making gains beyond what most of their competitors are doing, but that still have flaws.
For example, let’s look at Kellogg’s. Like many other cereal conglomerates, it uses wheat and oat crops treated with glyphosate, a carcinogenic herbicide. After being pressured by activists, the company decided to phase out the chemical by 2025.
Another example is Google, a carbon-neutral company that implemented many practices to maintain its environmental friendliness, including its use of 100% renewable energy. While it's been investigated for anti-competitive practice, its stellar environmental record qualifies it for inclusion in many ethical investment funds.
Specific ESG standards
Standards of environmental stewardship vary depending on the investment firm. However, there are a few ESG factors almost every firm considers, such as companies that have science-based carbon emissions targets vetted by independent experts.
These companies don't outrageously claim they're cutting down on carbon emissions using technology that hasn't even been invented yet. Businesses that are serious about minimizing their environmental impact also create plans for reducing emissions created by companies along their value chains.
A good fund manager will dig deeper than the data available in public reports. That's because relying purely on publicly available information doesn't always provide the most accurate depiction of an enterprise. Responsible fund managers will meet with the executive team and board of every company in their fund at least once a year.
3. Socially responsible investing (SRI)
Socially responsible investing is a mixture of the ethical and ESG methods.
An investor first uses negative screening to filter out companies involved in practices that go against their deeply held beliefs. Then, the investor uses an ESG scoring system to identify those companies that adhere to exceptional environmental, social, and internal governance policies.
4. Impact investing
This kind of investment focuses on the company’s impact on the planet.
This means that a fund manager using this approach might be okay with investing in enterprises involved in controversial activities like selling genetically modified foods if they can demonstrate they're doing everything they can to make the world a greener place.
5. Sustainable Investing
Sustainable investing is probably the most popular approach for the socially conscious investor. It encompasses all the other methods, including negative screening, positive ESG screening, and consideration of the business’s impact on the planet.
Will ethical investments make me money?
Like every other type of investment, ethical investment has its risks.
Several well-established ethical funds have experienced years of robust growth. However, this is no guarantee they’ll perform equally as well in the future.
Ensure that your portfolio is sufficiently balanced to shield you from potentially disastrous market downturns. Excluding companies that don’t fit in with your values makes this more challenging but not impossible.
How to find out how ethical a company is
You can learn more about a specific fund by reading through its prospectus. An easier way of doing this is to check out online tools that tell you where each fund stands on environmental issues. One of these tools is As You Sow, a shareholder advocacy group.
You can also glance over annual sustainability reports, which you can find by searching Google for a company’s name followed by the term “sustainability report.” Companies making solid environmental progress will have reports full of facts and statistics, not heartwarming stories. Look for concrete numbers with specific deadlines.
Check whether corporate governance has enough environmentally conscious people in it by searching for what these individuals' ecological priorities are.
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